A payday loan is a short term loan, usually quite a small amount, which is meant to help the borrower cover his or her expenses until the next payday. Sometimes these types of loans are known as cash advances. In the United Kingdom payday loans are growing rapidly with four times the number of people taking out payday loans nowadays compared to just three years ago.
The average loan amount is £300 and most borrowers earn less than £25,000 per year. There are no interest rate restrictions with payday loans, although they are legally obliged to advertise the amount of interest they charge.
So how do payday loans work? The borrower approaches the money lender with proof of their employment or income. This could be a payslip and bank statement for example. The borrower then writes a post dated cheque to the money lender which includes the loan and the fees charged for borrowing the money. When payday arrives, the borrower goes back to the store and repays the loan with cash. If the borrower fails to repay the loan then the money lender will cash the cheque. If the cheque bounces then the borrower will have to pay additional fees from their bank and from the money lender.
More recently, people do not have to go to a store to complete their loan application as they can do it online. This means that, if successful, the loan can be transferred directly into the borrowers account. Then, on payday, the money is simply taken from the borrower’s bank account. Some have claimed that payday lenders do not always run credit checks when giving loans this way, or even verify income because it is a much more secure way of getting the money back.
The benefits of payday loans are; they offer short term financial assistance to people who need small amounts of money urgently. Payday loans offer a service that help people who might not be able to borrow from their bank, if they have a poor credit history for example.
Critics of payday loans say that they are targeting the most vulnerable people in society and charging them hefty interest rates for the privilege. The money lenders however say that the charges are in line with costs. The money is borrowed for a short period of time so does not build up that much interest.
Other criticisms are that should people default on their payday loan then they will be aggressively pursued for the balance and threaten legal action.
As long as the borrower is aware of the implications then payday loans can be a good option for short terms lending.